- Money Morning Australia

Markets and The Madness of Crowds


Written on 12 January 2012 by MoneyMorning

Yes, I know that markets are irrational.

I read Charles Mackay’s 1841 classic, “Extraordinary Popular Delusions and the Madness of Crowds” long before it ever became fashionable.

Even so, when you think about it, 2011 must set some kind of record.

As investors, that means we need to decide whether this madness will continue in 2012 and which direction to take.


Take the madness in the bond world, for instance.

Long-term bonds of a country with an out-of-control budget deficit and a worrying trade deficit are currently yielding 1.6% below inflation.

In other words, year after year, investors are willing to pay 1.6% of their capital to hold them. On top of that, investors have been so keen on this miserable asset in 2011 they have bid up its price by no less than 26%.

Conversely, China is revolutionising the world economy.

Year after year, China puts up growth rates of 8% or more, and the latest data suggest that will continue throughout 2012.

What’s more, Chinese stocks stand on a bargain-basement price-to-earnings (P/E) ratio of less than 8-times earnings. Yet, in 2011, investors shunned these bargains, giving the Chinese market a pathetic return of minus-22%.

It’s Madness I Tell You

Do you see what I mean when I talk about irrational?

To a Martian, these statistics would be proof that earthly markets had lost their collective minds. That’s not just a random walk – it’s a deliberate stroll that will destroy your wealth.

For investors, it raises the question of how long this irrationality is going to last. Will this extreme irrationality persist in 2012, or will it reverse?

The first conclusion to be drawn is that current markets are unhealthy, and largely the product of government meddling.

Western governments have been pumping money into the global economy since 2008, and running budget deficits larger than ever before in peacetime. Meanwhile, the Chinese government has been engaging in massive “stimulus” itself, but financing it through the banking system.

When you look at current markets as massively distorted, the right conclusion becomes clear: [US] Treasury bonds are a bubble, inflated by massive money printing worldwide and the troubles in Europe.

And while they may have done well in 2011, they are likely to reverse sharply sometime in 2012. Therefore, Treasury bonds should be avoided at all costs.

As for the Chinese economy, it is facing severe headwinds due to massive problems in the banking system that will make some kind of crash and recession inevitable.

There’s always gold.

It may have fallen out of favor recently, as T-bond prices have soared even higher, but it looks a much better safe haven to me.

U.S. Federal Reserve Chairman Ben S. Bernanke has said he’s not increasing interest rates until the middle of 2013, the Bank of England has announced a huge new bond buying program, the European Central Bank (ECB) is certainly not going to tighten any time soon and Japan also looks unlikely to do so.

All that money has to go somewhere, and gold looks the obvious beneficiary.

Martin Hutchinson is a Contributing Editor to Money Morning (USA).

Publisher’s Note: This is an edited version of an article that first appeared in Money Morning (USA)

From the Archives…

A Story of Sell-Offs & Super Spikes by a Stock Market Trader
2012-01-07 – Murray Dawes

Why BHP Will Be the First Victim of China’s Economic Collapse
2012-01-06 – Kris Sayce

The Sun Starts to Set on China’s Economy
2012-01-05 – Kris Sayce

New Year’s Eve 2029: Will the Australian Stock Market Lose a Decade of Growth?
2012-01-03 – Kris Sayce

How to Buy Gold and Silver
2011-12-11 – Dr Alex Cowie

For editorial enquiries and feedback, email moneymorning@moneymorning.com.au


Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au


9 Comments For This Post

  1. M&M Says:

    News.com.au has an interesting take on boom & bust…

    http://www.news.com.au/business/skyscraper-craze-may-herald-credit-crunch/story-e6frfm1i-1226242708017

    Yes, I’m well reasearched.

  2. M&M Says:

    and bad at spelling.

  3. Roger Says:

    M&M….Hows the temperature in White Cliffs ? I am suffering in the heat on the Sunshine Coast but at least its better than last years floods.
    As we are building no skyscapers in Australia we must be going to be ok.
    I recall a similar comparison was made regarding womens hemlines. The shorter the hemline the more bouyant the economy. Judging by what I see the young ladies wearing today our economy must be just fine and dandy.

  4. M&M Says:

    Ha ha ha “;-)

    It’s late and I’m tired

    Cheers

  5. Peter Fraser Says:

    Roger it’s TRB who has the dugout at Whitecliffs.

    Please keep the weather temperate as I’ll be in Buderim this Saturday.

    There is money in chaos.

  6. TRB Says:

    PF come on MM is my sockpuppet and I have a few sockpuppets bloggers now buying bargain price dug outs in White Cliffs before the planets line up in December 2012 and cook the planet.

    Atleast you will be nice and cool underground in 2012.

  7. M&M Says:

    I want to ditto about the tweet thingy. Its #”**ing me off.

    Can’t read through it on my phone.

    ^^^^
    || || || ||?
    | o o |
    | “. |
    | |

    Sock puppet

  8. Peter Fraser Says:

    Actually I’m Nicks sock puppet. kinda like an alter ego for when his conscience gets the better of him and he questions his neo nazi white supremacy beliefs.

    Ah it’s good not being real…

  9. Roger Says:

    My apologies to M&M and TRB

TESTIMONIALS

"I think you're fantastic! I love to read what you write...you're so interesting and amusing and I've learned so much" -
Money Morning reader, Chris Gadd

"You guys are brilliant. I feel more relaxed about the future than ever simply because I know what is going on rather than floundering around with smoke screens and mirrors from the government and mainstream" -
Money Morning reader, Helen Carter

"Wow what can I say? I was an economically confused moron until I read your newsletter and even though I've been a subscriber for a short period I can now see how easy it is to understand, if you use common sense and can have the spin translated into everyday language. Thanks for an entertaining read." -
Money Morning reader, John

"Keep up the good independent and well thought out articles offering a view that often debunks mainstream myths." -
Money Morning reader, Craig

"I do admire your straight talking and simple analysis of the situation, I think of you as the Jeremy Clarkson of finance." -
Money Morning reader, Jeffery

openX sidebar signup form
Openx pos2
Latest Stock Market Updates
  • ^NDX4288.229+3.911 - +0.09%
  • ^FTSE6731.14+1.35 - +0.02%
  • ^AORD5368.600+47.700 - +0.90%
  • ^AXJO5384.300+49.500 - +0.93%
  • AUDUSD=X0.8538
  • USDJPY=X117.85
openX sidebar banner
Openx pos7
Iron ore leadgen
WWD dvd

World War D was billed as ‘the biggest investment summit of the decade’

It didn’t disappoint…


Absolutely mind-blowing beyond my expectations

– D.A.C. Hall


The BEST INFORMATION available,
contrary to mainstream economic reporting.

– L. Sceresini


Exciting, dynamic, passionate, informative, challenging, so professional... Brain-stretching.

– D Finlay


Click here to watch
the brand new Highlights Reel.

Blue Chips

Receive our unique and useful investments ideas straight to your inbox for FREE, enter your email to sign up:

x